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Wednesday, January 16, 2008

Expert Plan for Economy: If you rob me, then I will rob you

Experts say $150 billion stimulus needed

What does the Harvard professor want us to do about the ailing economy? What do the experts in Congress want us to do?

"Summers, an economics professor at Harvard University, had previously said $50 billion to $75 billion in tax cuts and pump-priming government spending is needed to boost the sagging economy. Now, his recommendation is double that — though perhaps employing a "trigger" that would release the money only if the economy worsens further." [italics mine]

"Democrats are coalescing around ideas such as extending unemployment benefits, boosting food stamp payments and doling out aid to ailing state governments."

"Sen. Edward Kennedy, D-Mass., said home heating subsidies and new job training programs should also be considered for a stimulus package."

I have an idea. How about the government "gives" each US citizen $1 Billion. That's right, each person will then be a billionaire. Now where would the government get this money you ask? Ok, good point, then let's just make it $500 Million.

In a previous post (
http://dougreich.blogspot.com/2007/04/wishing-for-non.html), I discussed Ayn Rand's idea that all of the evil in the world is in essence the result of wishing for things to not be what they are. I quoted the following passage from Atlas Shrugged:

“And that is the whole of their shabby secret. The secret of all their esoteric philosophies, of all their dialectics and super-senses, of their evasive eyes and snarling words, the secret for which they destroy civilization, language, industries, and lives, the secret for which they pierce their own eyes and eardrums, grind out their senses, blank out their minds, the purpose for which they dissolve the absolutes of reason, logic, matter, existence, reality – is to erect upon that plastic fog a singly holy absolute: their Wish.

“The restriction they seek to escape is the law of identity. The freedom they seek is freedom from the fact that an A will remain an A, no matter what their tears or tantrums -that a river will not bring them milk no matter what their hunger - that water will not run uphill, no matter what comforts they could gain if it did, and if they want to lift it to the roof of a skyscraper, they must do it by a process of thought and labor, in which the nature of an inch of pipe line counts, but their feelings do not - that their feelings are impotent to alter the course of a single speck of dust in space or the nature of any action they have committed."

Maybe she was onto something. The pursuit of a free lunch is not only impractical but immoral and destructive on an epic scale. (see the track record of religion and Marxism for starters.)

What really drives economic progress, i.e., real wages, living standards, etc.? The answer is productivity. If we can spend less time doing what we do now, it gives us more time to invent new things. Why is it that each of us don't have to spend all day hunting for food everyday or stockpiling wood for the coming winter? Practically 100% of the country used to be farmers. Now it's less than 5%. That frees up everybody else to invent wonderful new things and run businesses like restaurants and art galleries.

So what leads to productivity? Freedom - freedom to think, trade, and profit. Human wants are unlimited, and as long as people are free they will continue to make their lives better. Capital must flow freely to those most able to use it and they must be free to profit from their work. The government's function is to protect property and person. That's it. When the government does anything else it is a destroyer of capital.

Taxation destroy's capital and reduces or distorts incentives to work and invest in productive enterprises. The government's budget deficits crowd out capital from private usage by siphoning investment capital from business to the sewer hole of the federal budget. The government's inflation of the money supply (to fund its budget deficits) destroys capital in myriad different ways including but not limited to malinvestment and perverse tax effects. Regulation and licensing restricts people from trading freely and therefore restricts capital flow. To the extent that capital is destroyed, real wages decline and unemployment increases (Dr. Reisman has an excellent post on the relationship of inflation to economic inequality and stagnant wages, see http://georgereisman.com/blog/2008/01/credit-expansion-economic-inequality.html#links)

With all due respect to Professor Summers and Ted Kennedy the solution is: stop "stimulating" or "pumping and priming", and Let Us Alone!


Anonymous said...

I just wanted to point out that a substantial portion of Dr. Reisman's article is dedicated to showing that credit expansion will result in a malinvestment such that capital goods will be overpurchased. A Ctrl+F search of the article for "capital goods" reveals several instances of him discussing additional demand. About halfway through the article, he suddenly starts speaking about continuously decreasing capitalization as less and less capital goods are produced.

I'm not entirely sure that I understand the article quite in the way that Reisman intends it, but I think that it doesn't make sense to talk about increased demand for capital goods (which, other things equal, increases the total amount sold) and decreasing capital goods. In fact, I think that the entire second tangent about decreasing capital goods simply doesn't make sense in the context of a discussion about credit expansion.

Dr. Reisman is technically correct (he does divide the discussion on some level between that of credit expansion and that of general government interference). However, there is a fundamental contradiction in the claims and it absolutely does not behoove a rational theory (whether in ethics or economics) to promote contradiction. The thinking may be technically correct, but it is muddled and unclear. The goal of an economist is to make complex issues easier to understand, not to take concepts that have been made clear and obfuscate them.

The Rat Cap said...

I think you are saying you were confused because he seems to be stating that credit expansion leads to an increase in the demand for capital goods but at the same time seems to be saying that malinvestment (among other aspects of credit expansion) undermines production and actually destroys capital.

This argument is not contradictory. First, an increase in capital goods is not necessarily good if the capital is wasted on projects that only exist due to credit expansion. For example, how many real estate projects have been undertaken in the past few years in anticipation of higher real estate prices (and easily available loans), prices which indeed increased as a result of the government's credit expansion? This was "malinvestment" in his terms since as soon as the credit expansion reversed, these projects became insolvent and therefore ultimately represent a loss of capital.

In his book, he focuses more on how credit expansion is responsible for the boom-bust business cycle and how despite an initial increase in profit it actually leads to capital destruction and recession/depression. In this post, he shows how it also creates artificial economic inequality since it leads to sharply increased profit relative to wages. Also, as I explained above, in wasting capital through malinvestment, it undermines production and the accompanying rise in real wages. He goes on to show how other forms of govt interference lead to stagnant real wages.

I think the logical train is that credit expansion initially boosts profits at the expense of wages which leads to larger than otherwise economic inequality and also creates a boom-bust cycle which destroys capital, productivity and ultimately real wages. (For example, a business may experience an increase in nominal profits for which they are taxed at a higher rate yet they must replace their plant and equipment at higher cost and therefore actually experience a net loss.)

For more on how inflation destroys capital and leads to depressions it might help to re-read Chapter 19 “Gold and Inflation” specifically p. 930-939 where he describes "Inflation and the Destruction of Capital", “The Stock Market and Inflationary Depression” and “Inflation as the cause of Depressions and Deflation”.